First the fiscal cliff; now the fiscal ledges

On Jan. 3, President Obama signed a law that raises taxes on those making more than $400,000. And that decision turned a fiscal cliff into two more fiscal ledges.

The fiscal cliff — that cleverly engineered bit of Washington stagecraft — was poised in November to result in $7 trillion in tax increases and budget cuts over a decade.

The fiscal cliff would have increased income-tax and capital-gains-tax rates. Income taxes would rise — depending on income levels — from 10 percent to 15 percent, from 15 percent to 28 percent, from 25 percent to 31 percent, from 28 percent to 31 percent, from 33 percent to 36 percent, and from 35 percent to 39.6 percent. And the capital-gains rate would go up from 15 percent to 20 percent for most filers, according to CNNMoney.

On the spending side, the fiscal cliff was about something called “the sequester” — $1.2 trillion in automatic spending cuts over 10 years. Congress created the sequester in 2011, in exchange for agreeing to lift the debt ceiling.

The idea was to cut spending on “many government programs, even the popular ones,” according to CBS News. Let's look at some of those cuts — amounting to $109 billion in 2013:

•Medicare providers — not beneficiaries — would get a 7.6 percent cut;

•Farm subsidies and grants to states for social services departments and vocation and rehabilitation programs would suffer budget cuts;

•Defense spending would be slashed between 9.4 percent and 10 percent — amounting to a $55 billion reduction in 2013.

Forty percent of the cuts would go to so-called discretionary programs, according to CBS News, including “international aid, funding for NASA and the Department of Energy's research program, funding for national parks and the EPA's toxic waste and water cleanup programs,” among others.

Some programs would be exempt from the cuts — including the rest of “Medicare, Medicaid, Social Security, the children's health insurance program known as SCHIP, food stamps, veterans benefits and Pell Grants,” reports CBS News.

The deal that Obama signed earlier this month replaced the fiscal cliff with two fiscal ledges. The first one in February will be whether to raise the U.S. debt ceiling; and the second one will be cutting the budget.

The outcome depends on how well the competing sides of this debate manage the political process. The position of those on the Democratic side will be to demand that the first fiscal ledge be navigated on its own through a no-conditions increase in the debt ceiling to $16.4 trillion. The Republicans will try to tie that increase to the second fiscal ledge — a cut in government spending.

The outcome depends on whether Mr. Obama caves into Republican demands, as he did in September 2011, or whether he campaigns vigorously for his current position backing Republicans into a corner.

My guess is that Mr. Obama will choose the latter course, rather than the former. That is because of a change in his goals.

In September 2011, Mr. Obama was concerned about re-election and he thought that he needed to bend more to Republican demands in order to win a second term. Now that Mr. Obama has been re-elected and has learned more about how to use his power, he is going to be a tougher negotiator.

Of course, it is highly likely that Mr. Obama will need to give some ground to the Republican side in the negotiations. That is due to the looming threat by ratings agencies Moody's and Fitch of a downgrade in the U.S.'s AAA debt rating.

As we saw in August 2011 when Moody's put the debt rating on a watch for downgrade, investors reacted in the opposite way than many expected. Rather than increase America's borrowing costs, that move marked the beginning of a plunge in interest rates.

For example, prior to the downgrade, the interest rate on a 10-year U.S. government bond was about 3 percent, and it is now around 1.6 percent. The drop was due to the world's perception that Moody's got it wrong and, compared to the rest of the world, the U.S. was the safest place to park money.

Moody's and Fitch may downgrade the U.S. if the debt ceiling is raised without spending cuts. But I doubt that will happen since there is a chance that there will be more tax increases and some spending cuts — mostly in defense and a bit in Medicare and Social Security.

Since the fiscal ledges are merely stages on which to dramatize political struggles, it is worth noting that there is a civil war going on within the Republican Party. The tea party is pitted against more middle-of-the-road Republicans.

The tea party takes positions that are causing the GOP to lose the White House and to lose seats in Congress. But the tea party has the most money behind it; therefore its voice is amplified. Unless the tea party loses a substantial number of seats, the GOP's civil war will keep it in the minority.

Despite all this surface bubbling, there will be no double-dip recession, and navigating these fiscal ledges will yield limited turbulence on the economic recovery. I think that by the end of February, we will see some kind of deal that eliminates most of the so-called uncertainty that big companies claim has been holding them back from investing their $2 trillion in cash.

This resolution will unlock significant economic activity, including mergers, investment in technology and hiring. By the end of 2013, the Fed will begin to think about raising interest rates to keep inflation in check.

Peter Cohan of Marlboro heads a management consulting and venture capital firm, teaches business strategy, and is the author of 11 books – most recently, “Hungry Start-up Strategy: Creating New Ventures with Limited Resources and Unlimited Vision.” His column runs Sundays and Wednesdays on telegram.com. His email address is peter@petercohan.com.